WASHINGTON — Though the Dodd-Frank regulatory reform law designed separate rules for large and small institutions, covering everything from capital to stress tests to consumer protection, a consensus is growing that the higher standards for bigger institutions will eventually apply to everyone else.
"Two-tiered regulation by its nature falls apart because the regulators develop a familiar way of doing things, particularly for big banks, and they hold it up to the small banks," said Kip Weissman, a partner at Luse Gorman. "There's no question about it."
Under the bill, bank companies with more than $50 billion of assets are automatically considered systemically important and subject to tougher capital, liquidity and leverage rules. But banks below that threshold should pay attention to the standards, too, observers said.
"We would certainly hope that a systemic-risk regulator will go above and beyond disseminating those practices among systemic institutions and disseminate them among all institutions," said Kevin Jacques, the Boynton D. Much Chair in Finance at Baldwin-Wallace College. "Systemic risk hit more than 10 or 20 systemic risk institutions. It hit thousands."
Satish Kini, a co-chairman of Debevoise & Plimpton LLP's banking group, agreed it is no longer easy to separate large from small banks when it comes to certain regulatory requirements.
"I think bank holding companies that are not the largest bank holding companies will be covered by the higher standards," he said. "Those standards are apt to filter down. It may be risk management practices. It may be other types of things."
Many smaller banks may start looking to the public filings of the largest institutions to see how they are implementing new requirements, observers said. Most systemically important companies will have to detail new policies with the Securities and Exchange Commission, including heightened standards and risky activities identified by regulators.
"If you are an identified significant institution, I think there is going to emerge an obligation to tell people whether your activities or services might lead the Fed to impose additional regulations," said Joseph Lynyak, a partner at Venable LLP. "People will hopefully be able to see the dividing line for concerns by regulators, and people will pick up on that."
Some requirements may already be taking effect. Under a provision added by Sen. Susan Collins (R-Maine), trust-preferred securities will no longer count as Tier 1 capital after a transition period of six years. Though companies with less than $15 billion of assets have their existing trust-preferreds grandfathered in, and companies with up to $500 million of assets are exempted altogether, many do not expect the exemption to stick.
"The big thing that's going to trickle down is the Collins amendment and capital requirements," said Chip MacDonald, a partner at the Jones Day law firm in Atlanta. "Some of the smaller bank holding companies can still issue cumulative preferred and trust-preferred but can't issue it publicly, so people are going to have to manage their capital."
Paul Miller, a managing director at FBR Capital Markets Corp., said trust-preferred capital is already phasing out.
"You can't issue them anymore," he said. "It's a moot point. Those small guys that issued trust-preferreds issued them all into the CDO structures, and those CDO structures are broken down and won't be followed anymore."
Diane Casey-Landry, the senior executive vice president and chief operating officer of the American Bankers Association, said the Collins provision reinforced industrywide changes happening in anticipation of Basel III.
"Through Basel, you've already got more focus on pure equity, and Collins just accelerated that and the direction of Basel III," she said. "For the smaller banks, the smaller you are, the more difficult it is to raise capital, and trust-preferreds provided an affordable tool, and I feel we are going to have a lack of readily available capital for community banks."
Observers also pointed to the planned Consumer Financial Protection Bureau as a large opportunity to spread practices. Though CFPB rules will cover all banks, it only has enforcement power over companies with at least $10 billion of assets and systemically important nonbanks. But some said enforcement actions taken by the new agency against larger banks will be closely watched by the other agencies, who may use them as a template for smaller banks.
"If there is some practice found unfair and deceptive at Bank of America or Wells, it's fair to say the other regulators may take the same position for their institutions," said Michael Mierzewski, a partner at Arnold & Porter LLP.
For example, although lawmakers considered and rejected creating a "plain-vanilla" standard for mortgages, several observers said it may be created by default as the CFPB targets loan products it views as unfair or abusive.
"The overall impact of the legislation … will drive the industry toward plain-vanilla products and very cautious underwriting standards," said Andrew Sandler, a co-chairman of BuckleySandler LLP.
Community banks have already raised concerns about another part of the bill that is expressly not directed at them: interchange limits. Under the law, the Fed must write rules to ensure interchange rates for debit cards are "reasonable and proportional." Though the provision said community banks do not have to obey the Fed rules, observers said they will have to comply, in effect.
"The smaller institutions think that's going to trickle down because merchants will be putting pressure on their companies and their clients not just the big ones," said Cornelius Hurley of the Morin Center for Banking and Financial Law at Boston University School of Law. "The big ones will establish the industry standard, and the smaller ones will have to comply to compete."
Even stress testing, which the law requires for banks with more than $10 billion of assets, may become a standard of supervision.
"Over time, one emerging sound practice will be stress testing," said Richard Spillenkothen, formerly the head of supervision at the Fed and now a director in Deloitte & Touche LLP 's regulatory and capital markets consulting practice. "Looking at risk across firms in a coherent fashion, as in a stress test, can tell you a lot about an institution or the broader system. … Hopefully, the techniques supporting stress testing will be refined, improved and will be an area regulators will focus on increasingly over time."
Others said thrift holding companies will soon follow the standards of bank holding companies.
"I would envision over time there would be some changes in the structure of the thrift holding company … , at a minimum the capital requirements under the Bank Holding Company Act, so I think there will be a phase-in so you will see a melding of that," said Casey-Landry.